Lack of pension coverage is a major concern and should be declared a national priority. The government should therefore come up with a comprehensive umbrella organisation while simultaneously educating the public about pension schemes
H Sadhak
The Indian government took a bold step, though delayed, to reform the pension system by introducing the National Pension System (NPS) in 2004, which is mandatory for central government employees who joined services on or after January 2004. Pension reform and the introduction of a defined contribution (DC) system are a necessity and inevitable as the demographic dynamic of India is changing very fast. Ageing is becoming a challenging issue, which needs to be tackled through a well-designed institutional mechanism. Pension reform through the introduction of a DC system is a necessity due to three important reasons: (i) India is going to be the most populous country of the world by 2030?the growth rate of the elderly population is currently much higher, at 3.8%, than the overall growth rate of the population, at 1.76% (approximately in 2011). The proportion of the elderly (aged 60 years plus) in the population, which was 8.2% in 2008, is expected to go up 10.7% in 2021 and further to 21% in 2050. People over 80+ in 2050 would be about 15% of the total population.
Current coverage of the existing pension system is about 11%, that too of the organised sector workers and employees. More than 86% of the Indian labour force is engaged in the informal/ unorganised sector, which is not covered by any formal pension system. Studies have shown that more than 52% of elderly Indians depend on others for their survival and more than 72% females are fully dependent on others to survive. The existing defined benefit pension, which covers the organised sector, and that too mostly the civil servants and public sector employees, is totally unsustainable and needs to be revamped. During 1990-91 to 2009-10, the pension liability of the government as a percentage of tax revenue increased from 5.91% to 11.98% while the pension liability as a percentage of GDP increased from 0.91% to 1.92%. It is unfortunate that a large number of Indian are not aware of the emerging crisis due to an ageing population.
NPS, which was introduced in 2004 and became operational in 2008, is a well-conceived scheme having many significant features to emerge as an ideal model for pension reform in emerging and developing countries if implementation is efficient and institutionalised. Unlike many other countries, transition through NPS is smooth and almost no cost is involved. NPS is also not forced, except for government employees, and unlike many countries, risk has not been totally passed on to the members (except in the unorganised sector). There is a provision for subsidy (through Swavalamban) for poor people. Portability, investment options, switchover from fund managers and schemes, etc, make its structure elegant and simple. However, the implementation is not so effective and also suffers from certain structural weaknesses.
That said, even with some structural weaknesses and slow implementation, NPS has progressed reasonably well. Most of the state governments and a large number of corporates have joined NPS and a substantial number have joined the NPS Lite. Available data indicates that by October 2012, about 39 lakh members have joined NPS?26.8% in central government scheme, 36.8% in state government scheme, 32.47% in NPS Lite but only 3.9% in all-citizen scheme. The estimated total AUM by early October 2012 was estimated at R21,951 crore. Out of the total AUM, 65.16% was in the central government scheme, 30.53% in the state government scheme, 2.82% in all-citizens scheme and 1.49% in NPS Lite. Data reveals some significant facts that need to draw the attention of the regulator. In spite of six fund managers (four private sector and two public sector) driving the all-citizens scheme, it could mobilise R6,180 crore i.e. 2.82% of the total from only 1.5 lakh members, the bulk by SBI Pension Fund. Another fact that is quite encouraging is the fast growth of NPS Lite?though introduced only in July 2012, it attracted more than 12 lakh subscribers (more than 32% of total subscribers). Perhaps this was due to the initial subsidy through the Swavalamban scheme and driving the scheme through aggregators. Three issues arise?effectiveness of private fund managers, importance of government subsidy to induce potential members, and the role of distributors. These need further consideration.
Pension investment is a long-term issue and proven confidence and trust play a major role in investment decisions by the investors. Therefore, while giving licence to a sponsor to establish a pension fund, the regulator needs to ensure they would be able to generate enough confidence in the minds of investors. Second, the pension business is not purely a commercial proposition, particularly at this initial evolving phase, when a significant amount of social cost is involved. The regulator should therefore make sure that sponsoring organisations have that capacity and willingness to bear some social cost to popularise the pension concept and expand coverage. Financial literacy is also another issue that comes in the way of expanding coverage. Here, the individual agents play an important role as the first line financial educators and product distributors. The Indian life insurance market is an example where agents have played a crucial role for LIC all these days and the life insurance culture was established in India and LIC could emerge as the largest financial institution in India.
Pension is a major concern and should be declared as a national priority and all concerned (government and corporates) must have a responsibility to take it forward. In many countries, even for the non-government employees, joining the pension system is mandatory?why can it not be in India? Why can?t corporates also follow the same pattern as the government, where employees contribute 10% of their salaries, matching 10% by the government. It?s an issue that socially responsible corporates must think about.
Some other structural issues that need the urgent attention of the regulator include the bidding process for selection of fund managers to select the lowest bidder. This is an issue that has a bearing on risk management, research and governance. An extremely low management fee will adversely affect all these areas and finally the investors will suffer. The concept of L1 may not be very relevant. However, precautions need to be taken to keep the fund management fee under a limit. It?s suggested that there should be cap and floor?to ensure that no one quotes some ridiculously low fee which become detrimental to quality and risk. Another issue I have been focusing on for many years is the mark-to-market (MTM) valuation model, which often do not reflect the real asset value in the portfolio and generates inequity among the members. This arises due to investment in debt instruments?particularly corporate debt. The corporate debt market is illiquid, not so transparent, and most transactions are OTC, which makes acquisition costs higher. The regulator must think about a composite valuation model having tradeable and non tradeable securities in the portfolio; with the former to be valued on a MTM and the later to be valued on a held to maturity (HTM) basis.
Our pension portfolios are running significant reinvestment risks as most of the G-Secs have 10-year maturity, which do not offer any long-term solutions to manage inflation risk. Pension funds globally rely on long-term bonds linked to WPI to hedge inflation risk and to protect capital. These instruments are absent in the Indian market and risk management is a casualty. Even fund managers have not shown sufficient concern. If risk adjusted returns are to be provided to the investors, such financial instruments need to be introduced in the market. There are certain broader issues that need to be considered at the policymaking level to strengthen NPS and broadly the social security initiatives in India.
No pension system can be effectively regulated, supervised and monitored unless it has legislative support. PFRDA is functioning by an administrative instruction, which has limited scope. Therefore, PFRDA needs to be empowered through legislative approval with a defined role, authority and accountability. There are a plethora of schemes and initiatives relating to social security and pension in India?unorganised sector social security administered by the labour ministry, NOAPS administered by state governments and financially supported by the central government, EPFO and Special Provident Funds, social insurance managed by LIC, etc, and NPS. Same objectives but many initiatives. But, for effective implementation and coordination, there should be a national policy. The government should therefore come out with a comprehensive National Policy on Pension and Social Security (NPPS), which should be implemented and monitored by a National Council for Pension & Social Security (NCPS).
Another issue that needs the immediate attention of the government is regulatory responsibility of pension products. There is PFRDA regulating NPS products, there are pension products launched by life insurance companies regulated by IRDA, there are pension products launched by mutual funds regulated by Sebi and there is EPFO which acts as operator and regulator. This often creates conflicting situations as there are differences in tax benefits, investment practices, distribution mechanisms, fees, etc. Regulatory conflicts are detrimental to investors? interests and industry growth. Therefore, all pension products should be brought under a single regulator?PFRDA
Managing the pension system needs a special kind of skill, perception and vision as it has a wider and deeper ramification. Capacity is the core to design policy, products, governance, etc, which need long-term market experience, vision and commitment. This is lacking in the Indian pension space and need to be developed through a well-defined institutional mechanism. There is also a necessity for serious research and quality training for the stakeholders at all levels. To promote a pension culture, undertake research, conduct training and to generate policy inputs, an institution called the Indian Institute of Pension & Social Security (IIPS) to be managed professionally and by people of experience, commitment and vision, is needed.
Another important measure for capacity building is the induction of experience and expertise at all levels, including funds management, supervision and regulation. Here the practice introduced by the US Securities and Exchange Commission (SEC) can be thought of. Accordingly, working in a regulatory organisation and funds management must need at least five years of industry-level market experience.
Recently, a debate is going on about FDI. There is a proposal to allow 26% FDI in pensions. But where is the road map? I think there should be a clear road map for FDI, which is necessary, not only for capitalisation but also for technology, risk management, product innovation, etc, that are definitely lagging in the Indian pension fund industry, but are crucial for a sustainable pension system. A clear road map is also need for FDI infusion?which may start with 33% and extended to 49% on impact evaluation and contribution to NPS. On satisfactory performance and contribution, FDI can be extended further. There should be conditionality and accountability.
There are many other concern that need to be addressed but the above are critical to promote a sustainable pension system that can expand pension coverage and accumulate necessary pension assets in the accumulation stage so that accumulated assets can be translated into life annuity to generate sufficient pension for the elderly.
The author is an advisor (PwC) and former CEO, LIC Pension Fund. Views are personal. hsadhak@rediff.com
